U.S. rate-hike bets lose glare as inflation gets away
A shocking weak run of U.S. inflation data has investors cop out bets the Federal Reserve to meet its three targeted interest rate slogs this year, and has breathed fresh life into the bond market after an irregular start to the year.
This year, the Fed’s preferred measure of price pressures earlier had shown signs of breaking out of five years of inactive to reach the Fed’s 2 percent inflation goal, partly on hopes of the Trump administration’s fiscal stimulus.
But lack of progress on the Trump agenda, only a wisp of wage growth, and three straight months of falling oil prices have sapped that momentum.
Inflation in other major economies has plain or is weakening as well. On Thursday, the European Central Bank lowered its inflation forecasts.
Enlarged low price growth impairs the economy as companies struggle to conduct more for goods and services, salaries stagnate and investors get low returns.
Policymakers worldwide have fixed an annual 2 percent inflation rate as optimal for supporting healthy business and consumer spending growth.
U.S. bond yields and so-called equalized rates amid Treasury Inflation Protection Securities are the lowest in seven months and the gap between long- and short-dated bond supplies has reached the narrowest since last November. Few expect the trend to change soon.
Portfolio manager at Western Asset Management Co in Pasadena, California, John Bellows said, “The inflation background remains challenged. It will keep bond yields low.”
In May, the jobless rate hit a 16-year low of 4.3 percent. Investors widely expect the Fed to raise rates at its policy meeting next week as the economy moves toward the Fed’s command of full employment.
The Fed, which ended its near zero interest rate policy in December 2015, last raised rates in March to its target range of 0.75-1.00 percent. Conviction on a rate hike past next week’s Fed meeting is up in the air.
On Friday, federal funds futures implicit traders saw a coin-toss for another rate hike by year-end FFZ7. And the forward rate curve has demolished, suggesting less confidence in the Fed meeting its forecasts for three rate hikes in 2017 and another three in 2018.
The lowered rate-hike expectations since mid-March has helped to brace a bond market rocked by worries about a more asertive Fed and higher inflation under President Donald Trump’s policies.
From the end of 2016 to March 14, when the benchmark 10-year Treasury yield US10YT=RR reached its 2017 peak of 2.64 percent, Treasuries and other investment-grade bonds lost 0.44 percent, according to an index compiled by Barclays and Bloomberg .BCUSA
Since March 14, the Barclays/Bloomberg U.S. Aggregate bond index has produced a total return of 2.89 percent, bringing its year-to-date return to 2.44 percent.
Most scaring to investors and a few Fed officials is that the Consumer Price Index and other U.S. inflation barometers have existed or retreated from levels earlier this year, raising doubts about whether price growth could reach the Fed’s 2 percent goal.
The bond market has adjusted to the recent sluggish inflation data.
In the $13.9 trillion TIPS market, the yield gap between 10-year TIPS and benchmark 10-year Treasuries, a gauge of investors’ inflation expectations, has firmly narrowed since mid-March to 1.81 percent on Friday.
Explorers have stacked on bets in the futures market that the Fed may slow its rate hikes in light of the disappointing inflation data.
Investors are not upbeat about inflation outside the United States either. Their five-year price view on the euro zone in five years hovered above 1.50 percent on Friday, below the ECB’s 2 percent target.
Senior market strategist at U.S. Bank in Minneapolis, Bill Merz said, “Inflation isn’t taken off in most developed markets.”
But data showed some investors remain confident the setback in U.S. inflation is short term and price growth would speed up later this year.
According to Lipper, Thomson Reuters unit, “TIPS-focused funds have continued to attract money since late 2016, with their assets reaching an all-time peak of nearly $63 billion in the week ended June 7.”
Chief investment officer of fixed income at Voya Investment Management in Atlanta, Matt Toms said, “For the Fed to carry out more rate hikes, we need to see more inflation.”